EIU Global Forecasting Service

Enthusiasm for the euro will start to wane in the second half of 2018

January 18th 2018

Among G10 currencies, the euro made the biggest gains against the dollar in 2017, appreciating by 14% over the year as economic data went from strength to strength and some of the biggest political risks receded, particularly in France. Further supporting the currency, the European Central Bank (ECB) has begun reducing the pace of its asset purchases, and is slowly becoming more upbeat in its communication. However, interest rate rises are still a long way off, and the euro zone continues to face considerable political challenges, which will limit economic momentum. On balance, we expect the euro to hold steady against the dollar in 2018-19. Later in the forecast period it will resume its appreciation, owing to the turning of the US business cycle and the currency union's wide current-account surplus relative to the US.

The yen's appreciation against the US dollar since the end of 2016 has been much more modest. The Bank of Japan (BOJ, the central bank) remains committed to a loose monetary policy, targeting a 0% yield for ten-year govern‑ment bonds. Combined with growing investor risk appetite, this has maintained the Japanese yen as an attractive vehicle for carry trades. However, we believe that concerns over dwindling bond-market liquidity will prompt the BOJ to begin preparing financial markets for an eventual normalisation of its monetary policy settings, and to taper its asset purchases slowly from 2019. We expect this to prompt a further modest appreciation in the yen against the US dollar in 2018-19. Over the medium term the yen, like the euro, will receive additional support from a wide current-account surplus, and will continue to appreciate in nominal terms to offset Japan's relatively low inflation. Reflecting its status as a safe-haven currency, it will also be boosted by any detoriation in risk sentiment.